Has nasty, brutish, and short become the real new normal of today’s world? To judge by stock markets around the globe last week, it might seem so.
Not missing a beat after the horrific terrorist attacks by Islamic State operatives that took the lives of 130 people in Paris a week ago Friday, equity markets rallied, with Wall Street actually putting in its best week of the year.
Was this a manifestation of defiance or denial? The latter might have been the case previously, as when President Obama said the Islamic State had been “contained” in an interview with ABC News the day before the Friday the 13th Paris massacre. That description recalled the similarly unfortunate assessment by former Federal Reserve Chairman Ben Bernanke, who declared the spillover effects from subprime mortgages were “contained” in early 2007—only months before the crisis really began to unfold.
Equity markets do have a record of bouncing back from the initial blow imparted by acts of terror, as Liz Ann Sonders, Charles Schwab’s chief investment strategist, wrote last week in Barrons.com’s Wall Street’s Best Minds. Even after 9/11, the 12% hit when the U.S. stock market reopened was recouped a month later.
And after the London underground bombings in July 2005, there was only a 1.4% drop, which was recovered the next day.
But even on Monday, in the very first trading session following the heinous Paris attacks, stock markets not only didn’t buckle but moved higher. To be sure, the U.S. market seemed oversold and due for a bounce.
Still, the seeming indifference to the events of the previous Friday suggested that investors had grown a lot more callous in recent years.
Recall that the Flash Crash on the afternoon of May 6, 2010, which sent the Dow Jones Industrial Average plunging nearly 1,000 points in a matter of minutes, seemingly was precipitated by videos of protests in Athens against austerity measures needed to stay in the euro. I’ve lost track at this point of the number of Grexit crises; they all blur together. And, at the risk of sounding like Spiro Agnew, Richard Nixon’s vice president who resigned in disgrace, when you’ve seen one street demonstration, you’ve seen them all.
But by week’s end, bourses around the globe had put on sparkling showings in an extension of the advance that started last month—and as if nothing had happened in Paris. Asia, Tokyo, Shanghai, and Hong Kong were up by 1.4% to 1.6%. Closer to the attacks, Germany soared 3.8%, London by 3.5%, and even the Paris bourse was up over 2%.
And back in the U.S.A, the Standard & Poor’s 500 index put in its best week of 2015, gaining 3.3%.
To be sure, that followed one of the worst weeks of the year, in which the benchmark for big U.S. stocks shed 3.6%. Meanwhile, the Nasdaq Composite regained the 5000 mark and wound up 3.6% higher. And the Dow Jones Industrial Average was kicking it, adding 3.4%, with the help of Nike (ticker: NIKE), which jumped 5.5% Friday, on news of a stock split, a dividend hike, and an expanded share-repurchase plan.
What was especially striking was that the markets seemed to gain steam after Wednesday’s release of minutes of the Federal Open Market Committee’s meeting last month, which gave further confirmation that the U.S. central bank would raise rates at the coming two-day confab on Dec. 15-16.
As if much confirmation was needed, especially after the previous report of a bigger-than-expected 271,000 jump in nonfarm payrolls in October.
So, the long-awaited, and endlessly discussed, initial liftoff in the Federal Reserve’s interest-rate target from the near-zero (0% to 0.25%, to be exact) that’s been in place since the dark days of the financial crisis in December 2008 might finally be at hand. That’s a reason to bid up stocks?

WHAT GOT LESS MEDIA ATTENTION—but didn’t escape that of the market—was that the FOMC minutes strongly implied that even if the initial rise in the federal-funds target rate is imminent, the ascent will be milder and will not reach nearly as high as most forecasts indicate.
Specifically, the minutes discuss the notion of a real—that is, after adjusting for inflation—equilibrium interest rate. That rate would be associated with stable prices, a construct theorized by Swedish economist Knut Wicksell a century ago. Divining that golden mean isn’t obvious, but Thomas Laubach, a staff economist at the Fed’s Board of Governors, and John C. Williams, the president of the San Francisco Fed, have been studying the matter since early last decade.
In a recent paper, they reckon that this equilibrium real rate—which they dub r* from their equations—is about 0%. This is a moving target, but this rate had averaged about 2%—again, over the inflation rate—during the past half-century. Following the financial crisis and the Great Recession, they found, it was about a negative 1.5%. By implication, the 0% to 0.25% fed-funds target was about right.
Moreover, a “neutral” real fed-funds rate would translate to a nominal rate somewhere in the 2% range after taking inflation into account. Based on the forecasts derived from the market for Treasury Inflation Protected Securities, or TIPS, the inflation rate five years hence would be a shade under 2%, or 1.85%. (Wonks playing at home can look at the St. Louis Fed’s Website for the five-year, five-year forward inflation rate; everyone else can take my word for it.)
That’s well below the estimates of FOMC members contained in the dot-plot graphs most recently published after the September meeting. They guessed the equilibrium funds rate was 3.25% to 3.5%.
By the end of 2016, they thought the funds rate would be around 2.625%.
What’s this all mean? Start with the presumption that nothing gets into the heavily edited FOMC minutes by chance. While Laubach and Williams weren’t explicitly mentioned, their work has been followed avidly by Fed watchers and seems certain to be what was discussed by the panel. The notion of a 0% equilibrium real fed-funds rate also conforms to what has been dubbed the New Neutral by Pimco to describe the big asset manager’s expectation that interest rates will remain lower for longer.
That’s good news for financial assets, especially stocks. If bond yields remain historically low, equities’ allure is enhanced while corporations can continue to borrow cheaply to finance the return of cash to shareholders via stock repurchases and dividends.
So, even if the countdown for the liftoff in short-term rates is under way, their ascent is likely to be slow and they are apt to settle into a lower orbit than feared by bond bulls. For stocks, terrorist attacks apparently count less than continued low interest rates.

IN THE DEBT MARKET, reactions also weren’t what one might have expected.
Treasury bond yields moved lower despite the prospect of Fed short-term interest-rate hikes. Meanwhile, high-yield bonds, which normally tend to ape equities, slumped further and hovered near their low prices of the year.
The Treasury yield curve flattened, which means that the spread between shorter- and longer-dated yields contracted. That’s consistent with reduced expectations for future rate hikes. Specifically, the two-year note—the maturity most sensitive to Fed actions—hovered near the year’s high at 0.89%.
Meanwhile, the 30-year bond stood just above 3%, at 3.02%, to be exact, while the benchmark 10-year note was at 2.26%—both around the middle of their recent ranges.
Those yields look positively lush, compared with what’s offered elsewhere, especially in Europe. With minutes from the European Central Bank’s previous policy meeting strongly hinting at further easing, German two-year notes were sold at a record low negative yield of minus 0.38%. With the Fed likely to be going the other way, the euro continued its march to parity with the dollar, ending below $1.07.
But even with the prospect of continued low short-term interest, speculative-grade bonds are struggling. To be sure, a lot of that has to do with the plunge in oil prices (nearby U.S. oil futures managed to hold the $40-a-barrel line, which also encouraged stock bulls who have been taking their cues from the crude pits).
HighYieldBond.com, published by S&P’s Leveraged Commentary & Data, reported that its sample of junk bonds last week found that prices had slumped to their lowest level since 2011. That lifted their yield into double digits, to 10.05%.
Similarly, the iShares iBoxx $ High Yield Corporate Bond exchange-traded fund (HYG) ended the week just above its 52-week low. Leveraged loans also are laboring, as our colleague Amey Stone discusses in Current Yield.
Strength at the long end of the Treasury curve and softness in speculative-grade credits, either in bonds or bank loans, indicate continued disinflation. So does the strong dollar from likely Federal Reserve tightening and ECB easing, which is a depressant for already weak commodity prices as well as earnings of big-cap U.S. multinationals.
Heading into the de facto three-day week ahead of Thursday’s Thanksgiving break, stocks’ upward bias likely will be maintained. More than for that, give thanks that you and your loved ones are safe and well.